Feb. 26 (Bloomberg) -- Warren Buffett said his “trigger finger is itchy” for takeovers after cash holdings at his Berkshire Hathaway Inc. climbed to $38.2 billion.

“Our elephant gun has been reloaded,” Buffett said today in his annual letter to shareholders. Berkshire needs “good performance from our current businesses and more major acquisitions,” after the company reported a 43 percent gain in fourth-quarter profit on derivative bets and earnings from its Burlington Northern Santa Fe railroad, he said.

Buffett is seeking takeovers after Berkshire’s $13 billion 2010 profit increased the firm’s resources and near record-low interest rates limited the returns available in fixed-income markets. Buffett completed his biggest takeover, the $26.5 billion Burlington purchase, last February. Since then he’s said he’ll consider deals outside the U.S.

“He reloads at a rapid rate,” said Thomas Russo, a partner at Gardner Russo & Gardner, who has about 10 percent of his $4 billion under management invested in Omaha, Nebraska- based Berkshire. “The hunt for new investments, and wholly owned ones, I don’t think slows down whatsoever.”

Berkshire’s fourth-quarter net income rose to $4.38 billion from $3.06 billion. The profit for full-year 2010 was up 61 percent from 2009. Berkshire has advanced 5.9 percent on the New York Stock Exchange this year, beating the 4.9 percent advance in the Standard & Poor’s 500 Index.

Investing Approach

Buffett, 80, outlines his investing approach in his letters and opines about economics, executive compensation and government policies. His annual communications with shareholders have won him a following of professional money managers and the moniker “the Oracle of Omaha.”

“Commentators today often talk of ‘great uncertainty,’ Buffett wrote. “Don’t let that reality spook you. Throughout my lifetime, politicians and pundits have constantly moaned about terrifying problems facing America. Yet our citizens now live an astonishing six times better than when I was born.”

Buffett, who refers to Berkshire’s stockholders as “owners,” shuns quarterly conference calls with analysts and institutional investors, preferring to communicate by sending the letter and taking questions at the company’s annual meeting.

Acquisitions may help Buffett increase earnings for Berkshire as investment income at the company’s insurance subsidiaries slide. Investment income produced by units including reinsurer General Re and car coverage specialist Geico fell 5.9 percent in 2010 to $5.19 billion. Buffett said that may decline further in 2011 as investments he made during the credit crisis mature.

Perils of Leverage

Buffett warned in the letter about the perils of leverage and how his grandfather Ernest, a grocer, created a rainy day fund of $1,000 for his son Fred and similar funds for his other children. Buffett likened the savings to the minimum $20 billion in cash Berkshire customarily keeps on hand.

“By being so cautious in respect to leverage, we penalize our returns by a minor amount,” Buffett wrote. “Having loads of liquidity, though, lets us sleep well. Moreover, during the episodes of financial chaos that occasionally erupt in our economy, we will be equipped both financially and emotionally to play offense while others scramble for survival.”

Marmon Stake

Buffett said Berkshire will pay about $1.5 billion to increase its stake this year in Marmon, a unit of about 130 businesses, to 80 percent.

Goldman Sachs Group Inc. and General Electric Co. will probably return the $8 billion that Buffett invested in 2008 for securities paying 10 percent, Buffett said. Yields in fixed- income markets have fallen in the last two years, and Buffett, Berkshire’s chairman and chief executive officer, said in October that investors buying bonds after the decline were “making a mistake.”

The yield on two-year U.S. Treasuries fell to a record low of 31 basis points on Nov. 4 before rising to 71 basis points yesterday. The two-year note’s average yield over the last 10 years was more than 250 basis points.

To contact the reporter on this story: Andrew Frye in New York at afrye@bloomberg.net.

To contact the editor responsible for this story: Dan Kraut at dkraut2@bloomberg.net.

Fourth-quarter net income advanced to $4.38 billion, or $2,656 a share, from $3.06 billion, or $1,969, a year earlier, Omaha, Nebraska-based Berkshire said today on its website.

Buffett acquired Burlington Northern Santa Fe for $26.5 billion to add the second-biggest U.S. railroad to Berkshire’s collection of insurance, energy and consumer-goods units. The 80-year-old chief executive officer issued stock and debt to fund the deal for Fort Worth, Texas-based Burlington. Economic expansion in the U.S. fueled profit gains at the freight-hauling unit in 2010.

“The highlight of 2010 was our acquisition of Burlington Northern Santa Fe, a purchase that’s working out even better than I expected,” Buffett said in his letter to shareholders today. He said he’s looking for more “major acquisitions.”

Book value, a measure of assets minus liabilities, rose in the last three months of 2010 to $157.3 billion from $149.7 billion on Sept. 30 as earnings and stock advances boosted capital. The railroad contributed $1.03 billion in net earnings in the fourth quarter. Burlington had net income of $536 million in the fourth quarter of 2009 as an independent company.

Derivative Bets

“Kudos for that purchase, I was pretty skeptical at the beginning,” said Meyer Shields, an analyst with Stifel Nicolaus & Co. in an interview before the earnings were announced. “It was a good deal for him.”

The gain from equity index puts, in which Buffett bets on stock indexes, tripled to $2.49 billion as global markets advanced. Berkshire Class A shares advanced 5.9 percent on the New York Stock Exchange this year, beating the 4.9 percent gain in the Standard & Poor’s 500 Index.

The profit increase halts Berkshire’s streak of consecutive quarterly earnings declines at two. Net income fell in the second and third quarters of 2010 as derivative bets soured. Buffett, Berkshire’s biggest shareholder, uses the contracts to speculate on the direction of equity markets and the solvency of corporate and municipal borrowers.

Full-year net income rose 61 percent to $13 billion.

Railroad Results

Railroad earnings surged last year as the economic pickup increased demand for shipments of cars, coal and construction products. Union Pacific Corp., the largest U.S. railroad by 2009 revenue, posted a 41 percent fourth-quarter profit gain. Norfolk Southern Corp., the No. 4 railroad, hired 1,900 workers last year and will hire 1,500 more this year after business “outran our expectations,” CEO Charles Moorman said at a Feb. 15 conference.

Buffett is seeking acquisitions as earnings and maturing investments boost Berkshire’s cash holdings. At the end of December, the company had $38.2 billion of cash, its highest total in three years. Buffett has said he’ll consider purchases outside the U.S. He visited China in September and planned trips to Japan and India for this year.

“We will need both good performance from our current businesses and more major acquisitions,” Buffett wrote. “We’re prepared. Our elephant gun has been reloaded, and my trigger finger is itchy.”

The cash hoard will grow with the termination of financing deals that Buffett struck during the credit crunch. Swiss Reinsurance Co. repaid about $3 billion in a deal that gave Berkshire annual interest of 12 percent. Goldman Sachs Group Inc. and General Electric Co. are weighing the return of $8 billion that Buffett agreed to inject in 2008 for securities paying 10 percent.

Wells Fargo, Coca-Cola

The stock portfolio was valued at $61.5 billion at the end of the fourth quarter, up from $57.6 billion on Sept. 30, on gains in Coca-Cola Co. and Wells Fargo & Co. Buffett spent $372 million on equities and $2.78 billion on fixed-maturity securities in the quarter.

He sold about $1.35 billion of stocks and $1.79 billion of fixed-income holdings. Berkshire said in a filing this month that the company sold its stake in Bank of America Corp., ending an investment that spanned three and a half years in which the lender’s stock lost more than two-thirds of its value.

Insurance underwriting profit climbed to $414 million in the quarter from $335 million a year earlier. The pretax gain at Geico was $200 million, compared with a profit of $190 million in the last three months of 2009. Some fourth-quarter results were calculated by subtracting figures for the first nine months from the full-year data provided today.

Tank Cars, Trucking

Earnings at Marmon rose to $192 million from $160 million. The business has operations including the manufacture of railroad tank cars and wire and cable products. Berkshire purchased a majority stake in the company from the Pritzker family in 2008 and plans to pay about $1.5 billion this quarter for another 16.6 percent of the company.

Earnings at McLane increased to $91 million from $71 million. McLane delivers food and alcoholic beverages by truck to clients including Wal-Mart Stores Inc. and convenience shops. Profit at Berkshire’s furniture stores, jewelry shops and the candy business climbed to $122 million from $113 million.

NetJets, the luxury flight provider, posted pretax earnings of $49 million compared with a loss of $180 million a year earlier. David Sokol, chairman of Berkshire’s energy business, fired pilots and wrote down the value of aircraft after Buffett installed him as NetJets CEO in 2009.

To contact the reporters on this story: Andrew Frye in New York at afrye@bloomberg.net; Noah Buhayar in New York at nbuhayar@bloomberg.net;

To contact the editor responsible for this story: Dan Kraut at dkraut2@bloomberg.net.

The typical U.S. auto worker makes around $30 per hour, plus benefits. In China, a worker would be hard-pressed to earn $250 in a month. That makes the Land of the Great Wall a very attractive location to build automobiles, but a recent rash of strikes by workers at Toyota and Honda facilities has lead to rising wages, a trend that Automotive News reports is leading to more automation.

China's traditionally inexpensive labor meant that automakers could afford to utilize humans where the same task would be accomplished by a robot in higher cost countries like the U.S. or Canada. Both strikes and the anticipated rise of China's currency are but a couple of reasons automakers have increased by a reported 20-30 percent spending on robots, sensors, frequency converters and conveyors. And companies like Siemens in Germany and Rockwell Automation here in the States are reaping the rewards of the increased spending on automation as AN reports that stock prices at those companies are steadily rising.

AN quotes Wenjie Ge of Nomura Securities as saying that wages in China will double in only five years, adding "the pace of automation in Chinese factories is faster than Japan in the 1980s." Some analysts feel that China's economy is growing so fast that lower cost nations like Vietnam will soon take some of China's manufacturing jobs. But since China has quickly become the largest market in the world for auto sales, there's still a lot of vehicles built in China for many years to come.

Feb. 22 (Bloomberg) -- The smallest corn inventories in 37 years are a sign farmers around the globe are failing to produce enough grain to meet rising consumption, even as planting expands and food prices surge.

Growers from Canada to Russia boosted annual output of wheat, rice and feed grain by 16 percent since 2000, not enough to keep up with the 20 percent gain in demand, U.S. Department of Agriculture data show. While a Bloomberg survey of 25 analysts shows the agency on Feb. 24 may forecast a 3.5 percent increase in U.S. corn planting, the government says world stockpiles will equal 15 percent of use, the lowest since 1974.

Global inventories for all grain will drop 13 percent before the next harvest, the USDA estimates. That’s the first decline since 2007, when surging food prices sparked more than 60 riots from Haiti to Egypt. Increasing demand is causing isolated food shortages and accelerating inflation in developing countries even as it boosts farmers’ incomes and shifts planting strategies.

“We need to grow a huge crop this year to meet global food needs,” said Paul Jeschke, 58, who farms 3,600 acres (1,457 hectares) near Mazon, Illinois, and plans to boost corn planting by 50 percent because the crop is as much as $200 an acre more profitable than soybeans at current prices. “The increased demand for meat and dairy is driving demand for corn and soybeans.”

Rising incomes in developing countries are boosting food prices as people eat more meat and dairy products from crop-fed livestock. U.S. subsidies are fueling demand for ethanol made from grain, while droughts and floods in 2010 damaged global harvests.

Crop Prices Surge

Grain futures rallied this month to the highest since 2008 on the Chicago Board of Trade. Corn surged 95 percent in the past year to $7.2025 a bushel as of Feb. 18, wheat jumped 71 percent to $8.5575 a bushel, and soybeans advanced 44 percent to $13.81 a bushel. Rice gained 11 percent to $15.075 per 100 pounds.

Corn probably will reach a record $8 by 2012, and may touch $10 if the U.S. crop is disrupted, said Peter Sorrentino, who helps manage $14.4 billion at Huntington Asset Advisors. Goldman Sachs Group Inc. said on Feb. 10 that soybeans will rise the most, forecasting a 16 percent increase to $16 in the next three months. Wheat futures for delivery in December, after the U.S. harvest, trade at a 72.5-cent premium to the May contract, the widest spread since 2009.

Multi-Year Trend

“People have to eat, and we have a backdrop of falling stockpiles,” Sorrentino said by telephone from Cincinnati. “Even if we have a great harvest, we’ll just be getting back to levels people can be comfortable with in terms of stockpiles. The trend is going to be for increasing prices for years to come.”

The rally is encouraging farmers to plant more this year. The USDA, at its annual Agricultural Outlook Forum on Feb. 24 in Arlington, Virginia, probably will forecast an increase in U.S. corn planting to 91.281 million acres from 88.192 million, according to the average estimate in the Bloomberg News survey. Soybean planting may be little changed at 77.274 million acres, the survey showed.

Including winter varieties already in the ground and spring crops that will be sown before June, U.S. wheat farmers will plant a total of 57.206 million acres, up 8.8 percent from a year earlier, according to the Bloomberg survey. Even with increased acres, output may drop because growers will abandon more of the crop this year after dry weather hurt yields, according to Lanworth Inc., a crop forecaster in Chicago.

Declining Global Harvest

The global grain harvest was 2.179 billion metric tons during the past season, dropping 2.4 percent from 2010 and down for a second straight year, according to USDA data. While that’s up from 1.874 billion in 2000, it’s less than the department’s 2.235 billion-ton estimate of world consumption for this year.

Inventories before the Northern Hemisphere harvests will fall to 425.72 million tons from 487.88 million a year earlier and 27 percent less than what was on hand in 2000, the USDA said.

Tighter supplies helped boost global food costs by 25 percent last year, reaching the highest ever last month, according to the United Nations. The increase has pushed 44 million more people into extreme poverty since June, and the situation may worsen unless weather conditions improve and governments avoid trade restrictions, World Bank President Robert Zoellick said Feb. 15.

Commodity Rally

Grains weren’t the only commodities to rally. Raw-sugar futures in New York rose to a 30-year high this month of 36.08 cents a pound, and cotton reached a record $2.0893 a pound on Feb. 18 after doubling in the past year. Hog futures advanced this month to the highest since at least 1986 on the Chicago Mercantile Exchange, cattle touched a record in January, and milk futures rose to a 31-month high last week.

“Corn supplies are going to be extremely tight this year,” said Loyd Brown, the president of Hertz Farm Management Inc. in Nevada, Iowa, who helps manage about 500,000 acres in nine Midwest states. “When you consider that U.S. farmers harvested the third-largest crop last year, that means this is a demand market. You have to be bullish on agriculture. Global economic growth is driving demand for improved diets, and rising populations continue to boost exports.”

Farm Exports Surge

Overseas purchases of agricultural products from the U.S., the largest exporter of corn, soybeans, wheat and cotton, probably jumped 18 percent to a record $115.81 billion in 2010, the government said last week. China became the largest market for U.S. farm goods for the first time, as shipments increased by 34 percent to $17.5 billion, the data show.

China, the world’s most populous nation, has been leading the demand. The number of people in the Asian country grew 5.3 percent in the past decade, U.S. Census Bureau data show. During that period, as the economy more than quadrupled, urban incomes tripled to 19,109 yuan in 2010 while rural incomes more than doubled to 5,919 yuan, according to the government.

Chinese Meat Demand

“As developing economies expand and the middle class becomes larger, their logical step is to improve their diets,” said Bill Lapp, a former chief economist at ConAgra Foods Inc. who is president of Advanced Economic Solutions in Omaha, Nebraska. “A significant share of that improvement is not simply more calories, but a better diet that comes from more protein and dairy consumption.”

China, the world’s largest pork consumer, boosted demand for the meat by 30 percent since 2000 to an estimated 51.59 million tons this year, while beef consumption increased 6.7 percent, according to data compiled by the U.S. Meat Export Federation in Denver.

More grain is needed in China as livestock, dairy and poultry production shifts from small, family-owned farms with pastures to bigger, more-efficient industrial operations that feed animals mostly corn or soybean meal, according to Sterling Liddell, a vice president at Rabo Agrifinance, a U.S. unit of Utrecht, Netherlands-based Rabobank Nederland NV, the world’s largest farm lender.

Grain-to-Meat

About 7 pounds (3.2 kilograms) of corn is needed to produce 1 pound of beef, and it takes 4 pounds of the grain to get a pound of pork, according to Perry Vieth, the president of Granger, Indiana-based Ceres Partners LLC, an investment fund that has bought and manages about 15,000 acres of farmland in four Midwest states.

U.S. beef exports jumped to $4.08 billion in 2010, surpassing a record set in 2003 before an outbreak of mad cow disease led to import bans by countries including Japan and South Korea, according to the Cattlemen’s Beef Promotion and Research Board in Centennial, Colorado.

Grain demand is rising worldwide. Saudi Arabia’s cereal imports may reach a record this year, the UN said Feb. 3. Algeria, Morocco, Iraq, Bangladesh, Turkey and Lebanon issued tenders to buy wheat or rice this month, as food inflation stoked political unrest that toppled governments in Tunisia and Egypt. Wheat purchases by Algeria, North Africa’s largest importer after Egypt, climbed to 1.75 million tons in January, according to Goldman Sachs.

Indonesia, Bangladesh

Rice prices have climbed to records in Indonesia, the world’s fourth-most-populous country, and in Bangladesh, the biggest buyer in South Asia, the UN reported on Feb. 3.

Bangladesh may double its rice-import target this year to cool domestic prices, as consumers and farmers hoard the grain, the nation’s Directorate General of Food said. Indonesia is considering boosting stockpiles, and has removed import duties on wheat, wheat flour, soybeans, rice and livestock feed. The European Union is suspending import duties on some cereals this week through June to ease pressure on prices.

The crop rally has been a boon to producers. On Feb. 14, the USDA forecast net-farm income in the U.S. will surge 20 percent this year to a record $94.7 billion, allowing President Barack Obama to propose a 14 percent reduction in agricultural subsidies in his 2012 budget proposal.

Farm-Supply Companies

More cash for growers means more spending on farm supplies and equipment.

In the past month, Jeffrey J. Zekauskas, an analyst at JPMorgan Chase & Co. in New York, has raised his price targets for shares of Canadian fertilizer makers Agrium Inc., based in Calgary, and Potash Corp. of Saskatchewan Inc., based in Saskatoon. Analysts at Jefferies & Co. recommended this month that investors buy farm-equipment makers Deere & Co., based in Moline, Illinois, and Agco Corp., based in Duluth, Georgia, as well as crop-chemical and seed maker DuPont Co., based in Wilmington, Delaware.

While U.S. farmers want to plant more to take advantage of higher prices, many are already using the most-productive land, and the weather over the next eight months will remain a major influence on the size of any crop, said Dan Basse, the president of AgResource Co., a farm researcher in Chicago.

“We cannot rebuild the inventory cushion in one year,” said Basse, who has been studying agricultural markets since 1979. “We have reached an acreage wall where the U.S. can no longer be the world’s pillar of exports for corn, soybeans and wheat.”

Planting Outlook

Based on data available in November, the USDA estimated last week that U.S. planting for eight major crops, including cotton, will rise 4.1 percent to 255.3 million acres this year. The 10 million-acre increase would be the largest since 1996, when changes in farm legislation halted payments to farmers to idle land. The department will update that forecast this week.

Even a corn crop of 92 million acres “will not be enough to rebuild inventories because stocks are forecast to fall to 18 days of use,” said Terry Jones, 49, who farms 7,000 acres of corn and soybeans with his brother near Williamsburg, Iowa, and 3,500 acres of corn, soybeans and wheat in eastern Oklahoma. He said he is looking to buy more cropland.

“We can plant more acres, but demand is not backing off yet,” said Jones, who plans to sow corn on 67 percent of his fields, up from 60 percent last year. “Corn futures will likely rise to new highs, even if we have good weather this year.”

Compounding tight grain supplies are declining wheat-crop conditions from Australia to the U.S., after droughts and flooding limited output last year in Russia, Ukraine and Canada. On Feb. 15, Australia cut its forecast by 1.9 percent from December after heavy rain and flooding in the east.

U.S. Wheat Crop

U.S. production of winter wheat, the most common variety, may slump 8.8 percent to 1.355 billion bushels this year as farmers abandon 22 percent of acres, up from 15 percent last year, after unusually dry weather damaged yields, crop forecaster Lanworth said in a Feb. 11 report. The crop in Kansas, the biggest U.S. producer, was in the worst condition last month since 2002, government data show.

In China, where a drought already is reducing yield prospects for wheat, unusually warm, dry weather may limit output of corn and soybeans that are planted before June and harvested by November, said Joel Widenor, the director of agricultural services at the Commodity Weather Group LLC in Bethesda, Maryland.

About 42 percent of wheat fields in China’s eight major growing provinces were hurt by a dry spell that may last into the spring, Minister of Agriculture Han Changfu said Feb. 9. The country consumes the biggest share of the world’s wheat supply at 17 percent, data from the London-based International Grains Council show.

Weather Risks

Crops in North America face the biggest risk in the northern Great Plains and into the Canadian Prairies, where unusually cool and wet conditions will delay the snow melt and lead to late-season floods that pushes back some planting, Widenor said.

The main threat in the next three months will be for Plains winter wheat, where dryness will stress crops as they exit dormancy and begin to develop grain, Widenor said. U.S. corn and soybean crops may get warmer and drier weather than normal from South Dakota to Illinois to Texas, he said.

“This has been a demand-driven bull market,” said Jim Farrell, 56, the chief executive officer of Omaha-based Farmers National Co., which manages more than 2.4 million acres on 5,000 farms in 24 states.

“I do not think we can see a big enough increase in U.S. acreage to rebuild inventories back to a comfortable cushion in one year,” he said. “It is going to take two years of good weather and good yields. There is absolutely no room for any weather problems anywhere in the world this year.”

To contact the reporters on this story: Jeff Wilson in Chicago at jwilson29@bloomberg.net; Whitney McFerron in Chicago at wmcferron1@bloomberg.net.

To contact the editor responsible for this story: Steve Stroth at sstroth@bloomberg.net.

Alibaba.com Ltd. said Monday that Chief Executive David Wei and Chief Operating Officer Elvis Lee are both leaving the company with immediate effect, taking responsibility for fraudulent activity on one of the company's platforms.

.The company added in a statement that an investigation found that neither the two executives nor other members of senior management were involved in the activity, though nearly 100 of the company's 14,000 employees are suspected of abetting the fraud, some intentionally. Alibaba said it found a noticeable increase in fraud claims by buyers against certain suppliers on its business-to-business platforms starting in late 2009 and through much of 2010.

Jonathan Lu, CEO of sister site Taobao.com, China's largest domestic e-commerce website, will now separately run Alibaba.com as well, said John Spelich, spokesman for parent company Alibaba Group. The e-commerce conglomerate, roughly 40% owned by Yahoo Inc., also operates online payment system Alipay.

Mr. Wei was credited with being a key driver of the company's long term-strategy, and had been working on a plan to make Alibaba.com a place for online merchants to source their products for sale on websites like eBay and Taobao. The announcement said Mr. Lu will be well suited to continue that, but it's unclear how easily the company will recover from such a major management change.

Mr. Lu will "take leadership of the teams of people working on strategic direction of Alibaba.com," said Mr. Spelich, adding that he has credibility within the company as one of its earliest members. Mr. Lu has been with Alibaba Group for 11 years and has worked on multiple products.

The company said the management changes will have no impact on its financial filings, but the company will monitor any impact on its future business prospects.

Alibaba said the fraud investigation started when someone internal noticed suspicious activity and flagged it to the board. In 2009 and 2010 fraud complaints were lodged against more than 2,300 suppliers that had paid Alibaba.com for "Gold Supplier" accounts, meaning the site listed them as Alibaba-verified legitimate businesses. Many were found to have been set up to intentionally defraud customers.

"We are working with law enforcement to go after suppliers that engaged in intentional fraud and we are, as we've always done, willing to assist buyers who were defrauded," Mr. Spelich said.

He pointed to a fair-play fund established at the end of 2009 to provide defrauded buyers a "partial good-faith" payment, taken from the subscription fees of fraudulent suppliers. The company says the fraudulent suppliers made up around 1% of all suppliers in 2009 and 2010.

The company said in its statements that the fraudulent sites generally offered high-demand consumer electronics low prices with small minimum orders and "less reliable" payment-transfer methods. It said the average claim by buyers against the fraudulent suppliers was US$1,200.

Yuanta Securities analyst Liu Yixuan said Alibaba's revenue-growth momentum could slow down in the short term as it looks to clean up fraudulent accounts.

"However, we expect the growth in customer numbers and revenue should remain robust in the long run," Mr. Liu said.

In November, Alibaba said it had terminated 1,200 paying members that had been reported as and proved to be fraudulent but also members that demonstrated a high probability to commit fraud.

"We believe that the voluntary clean-up of membership base is important in improving overall supplier quality on our marketplace," it said at the time.

Write to Yvonne Lee at yvonne.lee@wsj.com

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Feb. 17 (Bloomberg) -- Iran is arranging with Egyptian officials to have two of its warships use the Suez Canal, Iranian state-run Press TV said. The Suez Canal Authority said after today’s report that no Iranian naval vessels had been granted permission to sail through the waterway.

Israeli Foreign Minister Avigdor Lieberman said yesterday that Iran was planning later that day to send two gunboats through the canal to Syria, which would involve heading through the eastern Mediterranean, off Israel’s coast. He called the move a “provocation.”

“It’s meant as a clear provocation to Israel, and is also an attempt by Iran to change the subject from the fact that, while Tehran welcomed the downfall of the Egyptian government, they have a problem at home right now where a certain section of their own people would like to see that regime also fall,” Jonathan Spyer, a political scientist at the Interdisciplinary Center Herzliya near Tel Aviv, said in a phone interview.

Concern that anti-government unrest in Egypt would disrupt canal traffic sent oil prices to a two-year high on Feb. 2. The 120-mile (190-kilometer) Suez Canal carries about 2.5 percent of world oil output, according to Goldman Sachs Group Inc., and is a key route for ships carrying Asian consumer goods to Europe.

Iran’s opposition called for nationwide rallies Feb. 20 to mourn those killed in anti-government protests this week, according to the website of former Prime Minister Mir Hossein Mousavi, who challenged President Mahmoud Ahmadinejad in the 2009 election. Iran has sought to crush anti-government protests at home, including Feb. 14 rallies inspired by the revolts in Egypt and Tunisia that ousted their leaders.

Naval Official

Press TV cited an unidentified naval official as saying Iranian officials were in contact with Egypt to arrange passage for the warships and that Egyptian authorities believe there was nothing wrong with their planned journey. The broadcaster said the official was confirming previous reports that Iranian warships would use the waterway.

“We don’t have any information or a license from any ministry in Egypt,” the canal’s head of traffic, Ahmed El Manakhly, said by phone after the Iranian report. The Defense Ministry must approve any vessel’s use of the canal, he told Bloomberg Television before the Iranian report. “According to the rules which govern navigation through Suez -- international rules -- we cannot forbid any vessel from passing through the Suez Canal if there is no war between Egypt and that country.”

Oil, Franc

Oil prices rose after the Iranian report, with Brent crude increasing 42 cents to $104.20 a barrel. In New York, crude rose 23 cents to $85.22 a barrel.

The Iranian navy’s use of the canal would be “both a provocation and their right,” Cliff Kupchan, Iran analyst at the Eurasia Group, said in a telephone interview from Washington. “Given they haven’t done it in a long time and they are doing it in the context of Middle East instability, it is certainly a provocation.”

Kupchan said the use of the canal by Iranian warships would be important because it would “signal Iran’s growing influence in this time of flux.” He said, “These guys are masters at disinformation, roiling markets, keeping everyone guessing. Sometimes they pull the punch, sometimes they throw the punch.”

Iran hasn’t sent warships through the canal in “many years,” Lieberman said yesterday. The ships are a British- built, 1960s-era Mk-5 frigate and a supply vessel, according to Israel’s Yedioth Ahronot newspaper.

Jewish Leaders

Lieberman, who made the remarks in a speech in Jerusalem to U.S. Jewish leaders, said another provocation by Iran was the October visit to southern Lebanon by Iranian President Mahmoud Ahmadinejad. The Israeli minister compared Ahmadinejad to Hitler in a December interview in Newsweek.

The Iranian vessels are meant to be on a cadet training cruise and have a right to use the canal, Gary Sick, a member of the U.S. National Security Council under presidents Gerald Ford, Jimmy Carter and Ronald Reagan and the principal White House aide on Iran during the 1979-81 hostage crisis, said in a telephone interview.

“As far as I know, this is not an attack on anyone,” he said. “It’s hard to see how two ships on a training cruise through Jeddah and making a stop through the Red Sea is a threat to Israel.” The Israeli foreign minister “would certainly complain if Israel was not allowed to pass through the Suez by a successor government that was very critical of Israeli policies, and he’d be very right,” Sick said.

Regional Unrest

Israeli leaders have voiced concern that Iran may exploit the instability in the region following the Feb. 11 ousting of Egyptian President Hosni Mubarak.

Iran has accused the U.S. and Israel of stoking dissent in the country and rejects international sanctions against its nuclear program. Iran has said discussions of Israel’s nuclear development should be part of any talks on its own atomic work. Israel hasn’t confirmed or denied possession of nuclear weapons.

Israel and the U.S. suspect that Iran’s nuclear program is aimed at producing weapons. Iran says its atomic installations are for generating power. The United Nations has imposed four rounds of sanctions on Iran over its nuclear development.

“The international community must understand that Israel can’t ignore forever these kinds of provocations,” Lieberman said in the speech in which he discussed the ships.

To contact the reporters on this story: Benjamin Harvey in Ankara at bharvey11@bloomberg.netVivian Salama in Cairo through the Dubai newsroom at vsalama@bloomberg.net.

To contact the editors responsible for this story: Mahmoud Kassem at mkassem1@bloomberg.net; Andrew J. Barden at barden@bloomberg.net.

Feb. 16 (Bloomberg) -- Arab nations have rejected a U.S. offer to increase pressure on Israel to stop West Bank settlement construction in exchange for Arab agreement to withdraw their United Nations draft resolution demanding a halt to all such building, three diplomats said.

Susan Rice, the U.S. ambassador to the UN, presented the deal to Arab ambassadors yesterday in an effort to avoid having to veto their resolution, according to the diplomats, who spoke on condition of not being identified because she wanted the proposal to be kept confidential.

A committee of Arab foreign ministers rejected the deal, and their UN ambassadors informed Rice of the decision today, the diplomats said. Ibrahim Dabbashi, Libya’s deputy UN ambassador, said in a telephone interview that a vote on the draft resolution would be called in the Security Council tomorrow or Feb. 18.

The U.S. mission to the UN declined to comment on the meetings.

The draft resolution, which would declare the construction illegal, was circulated to Security Council members last month. The U.S. has said it opposes bringing the issue to the panel, where 14 of the 15 members would likely vote for it.

Rice told the Arabs the U.S. would support stronger statements on settlement construction and other issues in the Israeli-Palestinian conflict by the Security Council and the Middle East Quartet, which is composed of the U.S., Russia, the UN and the European Union, the diplomats said. They said she also indicated that the U.S. would consider backing a Security Council trip to the Middle East that Russia has proposed.

Quartet’s ‘Regrets’

The Quartet, which is scheduled to meet on March 15, stopped short of calling for a halt to settlement activity in a Feb. 5 statement, saying only that it “regrets the discontinuation” of Israel’s 10-month moratorium on settlement construction.

The U.S. opposes “attempts to take these issues to this council and will continue to do so, because such action moves us no closer to the goal of a negotiated final settlement,” U.S. Deputy Ambassador Rosemary DiCarlo said in a Jan. 19 meeting of the Security Council.

She reiterated the U.S. view that “continued settlement expansion is corrosive, not only to peace efforts and the two- state solution, but to Israel’s future itself. Like every U.S. administration for decades, we do not accept the legitimacy of continued Israeli settlement activity.”

Incentives Package

President Barack Obama last year offered Israel a package of incentives to halt settlements that included a pledge to block such proposed resolutions in the Security Council, and then abandoned attempts last month to broker a freeze on construction after Israel refused to halt building.

About 500,000 Jews have moved to the West Bank and East Jerusalem since Israel captured the territories in the 1967 Middle East war. The UN says the settlements are illegal, and the International Committee of the Red Cross says they breach the Fourth Geneva Convention governing actions on occupied territory.

Israel says the settlements don’t fall under the convention because the territory wasn’t recognized as belonging to anyone before the 1967 war, in which Israel prevailed, and therefore isn’t occupied.

To contact the reporter on this story: Bill Varner at the United Nations at wvarner@bloomberg.net

To contact the editor responsible for this story: Mark Silva in Washington at msilva34@bloomberg.net

Feb. 16 (Bloomberg) -- Asian stocks gained, with Japan’s Topix index set for its longest winning streak since August 2009, while the dollar and yen slid on optimism U.S. economic reports will signal a stronger recovery. Japanese government bonds fell.

The MSCI Asia Pacific Index added 0.2 percent to 137.86 as of 11:15 a.m. in Tokyo, where the Topix advanced for an eighth straight day. Standard & Poor’s 500 Index futures climbed 0.2 percent. The dollar and yen weakened against most of their major counterparts. Treasuries retreated for the first time in four days. Yields on Japan’s 10-year debt rose to near the highest since April. Wheat and oil rebounded from yesterday’s losses.

U.S. data today may show industrial production gained and producer prices increased last month, while a report tomorrow may show European consumer confidence improved. Investor optimism was tempered by flaring protests in Bahrain, Yemen and Iran, and as the World Bank warned that soaring food prices have pushed 44 million more people into extreme poverty since June.

“Economic data show the global economy remains on the recovery track and risk sentiment is improving,” said Masahide Tanaka, a senior strategist in Tokyo at Mizuho Trust & Banking Co., a unit of Japan’s second-largest bank. “Currencies tied to growth including the euro are likely to be bought in this environment and the yen and dollar to be sold.”

Seven shares climbed for every six that fell on MSCI’s Asian Index. The Topix rose 0.5 percent, led by Mitsubishi Estate Co. and Sumitomo Realty & Development Co., after Nomura Holdings Inc. said Japan’s economic lull is nearing an end.

‘Further to Run’

“The cyclical recovery in shares is panning out broadly as expected and has much further to run,” Shane Oliver, head of investment strategy in Sydney at AMP Capital Investors Ltd., said in a note to investors today. “Shares are still cheap, confidence in the sustainability of the global recovery is continuing and share market liquidity remains favorable.”

Dell gained 5.8 percent in extended trading. About 73 percent of the companies on the S&P 500 that have reported since Jan. 10 have posted quarterly earnings that topped forecasts. U.S. stocks retreated yesterday, dragging the S&P 500 down from a 32-month high.

U.S. Economy

U.S. industrial production climbed for a third month, rising 0.5 percent in January from December, according to a Bloomberg News survey before today’s report. Separate reports on housing starts and producer prices are also due today.

Yields on 10-year Treasuries gained two basis points to 3.62 percent. Treasuries have handed investors a 1.2 percent loss in February, based on Bank of America Merrill Lynch data. Yields on Japan’s benchmark 10-year bond rose to 1.315 percent from 1.305 percent yesterday, when the nation’s central bank said the economy is gradually emerging from its “deceleration phase.”

The yen dropped to 113.32 per euro from 112.99 in New York yesterday, after falling to 113.44 on Feb. 11, the weakest since Jan. 28. The dollar weakened to $1.3532 per euro from $1.3487. An index of consumer sentiment in the 17-nation euro area improved to minus 11 this month from minus 11.2 in January, a separate Bloomberg survey showed before tomorrow’s data.

Wheat for May delivery increased as much as 0.7 percent to $8.78 a bushel after dropping 3.5 percent yesterday, the most in three months. Prices gained on concern that increasing global demand may outpace supply hurt by drought and rains, eroding inventories.

Oil, Middle East

Oil for March delivery rose 0.3 percent to $84.61 a barrel on the New York Mercantile Exchange, snapping a three-day drop. Futures fell 0.6 percent yesterday after analysts surveyed by Bloomberg News estimated an Energy Department report today will show gasoline stockpiles climbed 1.85 million barrels in the seven days ended Feb. 11. Brent crude traded above $101 a barrel in London.

Bahraini protesters may rally for a third day today after the funeral for the second demonstrator killed during clashes in the Persian Gulf State. Security forces in Iran, the second- largest OPEC producer, this week used tear gas to break up the biggest anti-government protests since the aftermath of the disputed presidential election in June 2009.

Egyptian regulators said yesterday they will weigh the cancellation of transactions that led to the biggest tumble in the EGX 100 Index in more than two years. The stock exchange plans to resume operations on Feb. 20. The nation’s benchmark dollar bonds due in 2020 fell for a second day yesterday, pushing up the yield to 6.57 percent, according to data compiled by Bloomberg.

To contact the reporters on this story: Shiyin Chen in Singapore at schen37@bloomberg.net; Monami Yui in Tokyo at myui1@bloomberg.net.

To contact the editor responsible for this story: Nicolas Johnson at nicojohnson@bloomberg.net.

Imagine that your local city and county controlled all land rights, and the only ownership a private builder or developer could secure was a long-term lease. Now imagine that 40% of the city and county's revenues come from the lease fees paid by developers. Next, imagine a giant real estate bubble has priced most residents out of the market, and that the local governments are reaping huge gains as the development rights and leases they sell are skyrocketing.

Can you say conflict of interest?

That's the Chinese real estate dynamic in a nutshell. Local governments have every incentive to push lease prices higher, further fueling China's real estate bubble, and zero incentive to build low-cost housing for the average citizen.

Who Benefits

Minxin Pei, professor of government at Claremont McKenna College and a senior associate at the Carnegie Endowment for International Peace, recently described who benefits from what he termed China's "irrationally exuberant" property market: Local government and its officials, and state-owned enterprises (SEOs), which have exploited their ties to government-controlled banks to enter the speculative real estate market with a vengeance.

"With access to almost unlimited no-cost credit from the state-controlled banking system," he wrote, "these behemoths have abused their financial clout and plunged headlong into the real estate market, snapping up high-priced land and investing in high-end residential housing units that now sit empty across the country."

Once you understand this dynamic, it's not difficult to see why China's housing bubble will end badly. Local governments are so heavily dependent on development fees and taxes for their revenues that any fallback in new development will spell catastrophe for city and regional government budgets.

Who Pays for the Bailout

Who will lose when the bubble inevitably deflates?

Residents will suffer because government services will have to be slashed as revenues from development fees collapse.

The Chinese investors who overpaid for grossly inflated luxury condos will suffer massive losses, developers dependent on a fast-rising bubble market will go bust, and somebody will end up covering the losses as bankrupt developers renege on their loans.

Since most of the loans came from government-owned banks, then that "somebody" will be the Chinese taxpayer. Sound familiar?

"China's taxpayers will twice be made the victims by the housing bubble," Professor Pei noted. "In the bubble years, they're priced out of the market for affordable housing. When the bubble bursts, they'll pay for the cleanup. When Chinese state-owned banks write off their bad loans, they don't do so with money growing on trees. Instead, the Ministry of Finance will issue bonds to recapitalize the banks -- and fund the bailout with future tax receipts."

How Big a Bubble?

Recent reports estimate there are 64.5 million vacant "investment" flats in China. Analyst Andy Xie recently laid out the risks this giant speculative bubble poses to China's local governments and banks.

"Local governments in China depend on real-estate deals for revenue and could default if the market falls too far," he wrote. "Notice the bind China is in. It has to keep the bubble going to preserve local government finances. They've become a classic Minsky Ponzi unit."

If the Chinese central government keeps the bubble inflated with easy money, Xie concluded, the resulting crash and bailout will only be that much more painful.

Local Officials Benefit Personally from Bubble

While contributions from property developers tend to have outsized political influence in much of the world, local government officials in China are brazenly pocketing the proceeds from development. For example, the majority of homes in a newly launched subsidized housing project in Shaanxi Province have been handed to local government officials.

Add up these factors -- widespread corruption, a real estate bubble that's priced average citizens out of the market, local governments dependent on new development for their revenues and a government-run banking sector that will turn to taxpayers to fund the inevitable bailout -- and there's plenty of fuel for taxpayer resentment and anger once the bubble pops.

Sound familiar?

Based on the accounts of these analysts, Chinese taxpayers will soon have common ground with their American counterparts: They, too, will be stuck paying for the bailout of private developers and government-controlled banks (which in the U.S. are called Fannie Mae and Freddie Mac).

Feb. 14 (Bloomberg) -- Barack Obama may lose the advantage of low borrowing costs as the U.S. Treasury Department says what it pays to service the national debt is poised to triple amid record budget deficits.

Interest expense will rise to 3.1 percent of gross domestic product by 2016, from 1.3 percent in 2010 with the government forecast to run cumulative deficits of more than $4 trillion through the end of 2015, according to page 23 of a 24-page presentation made to a 13-member committee of bond dealers and investors that meet quarterly with Treasury officials.

While some of the lowest borrowing costs on record have helped the economy recover from its worst financial crisis since the Great Depression, bond yields are now rising as growth resumes. Net interest expense will triple to an all-time high of $554 billion in 2015 from $185 billion in 2010, according to the Obama administration’s adjusted 2011 budget.

“It’s a slow train wreck coming and we all know it’s going to happen,” said Bret Barker, an interest-rate analyst at Los Angeles-based TCW Group Inc., which manages about $115 billion in assets. “It’s just a question of whether we want to deal with it. There are huge structural changes that have to go on with this economy.”

The amount of marketable U.S. government debt outstanding has risen to $8.96 trillion from $5.8 trillion at the end of 2008, according to the Treasury Department. Debt-service costs will climb to 82 percent of the $757 billion shortfall projected for 2016 from about 12 percent in last year’s deficit, according to the budget projections.

Budget Proposal

That compares with 69 percent for Portugal, whose bonds have plummeted on speculation it may need to be bailed out by the European Union and International Monetary Fund.

Forecasts of higher interest expenses raises the pressure on Obama to plan for trimming the deficit. The President, who has called for a five-year freeze on discretionary spending other than national security, is scheduled to release his proposed fiscal 2012 budget today as his administration and Congress negotiate boosting the $14.3 trillion debt ceiling.

“If government debt and deficits were actually to grow at the pace envisioned, the economic and financial effects would be severe,” Federal Reserve Chairman Ben S. Bernanke told the House Budget Committee Feb. 9. “Sustained high rates of government borrowing would both drain funds away from private investment and increase our debt to foreigners, with adverse long-run effects on U.S. output, incomes, and standards of living.”

Yield Forecasts

Treasuries lost 2.67 percent last quarter, even after reinvested interest, and are down 1.54 percent this year, Bank of America Merrill Lynch index data show. Yields rose last week to an average of 2.19 percent for all maturities from 2010’s low of 1.30 percent on Nov. 4.

The yield on benchmark 10-year Treasury note will climb to 4.25 by the end of the second quarter of 2012, from 3.63 percent last week, according to the median estimate of 51 economists and strategists surveyed by Bloomberg News. The rate was 3.64 percent as of 2:08 p.m. today in Tokyo. The economy will grow 3.2 percent in 2011, the fastest pace since 2004, according to another poll.

“People are starting to come to the conclusion that you’ve got a self-sustaining recovery going on here,” said Thomas Girard who helps manage $133 billion in fixed income at New York Life Investment Management in New York. “When interest rates start to go back up because of the normal business cycle, debt service costs have the potential to just skyrocket. Every day that we don’t address this in a meaningful way it gets more and more dangerous.”

‘Kind of Disruption’

While yields on the benchmark 10-year note are up, they remain below the average of 4.14 percent over the past decade as Europe’s debt crisis bolsters investor demand for safer assets, Bank of America Merrill Lynch index data show.

“The market is still giving the U.S. government the benefit of the doubt,” said Eric Pellicciaro, New York-based head of global rates investments at BlackRock Inc., which manages about $3.56 trillion in assets. “What we’re concerned with is whether the budget will only be corrected after the market has tested them. Will we need some kind of disruption within the bond market before they’ll actually do anything.”

Still, U.S. spending on debt service accounts for 1.7 percent of its GDP compared with 2.5 percent for Germany, 2.6 percent for the United Kingdom and a median of 1.2 percent for AAA rated sovereign issuers, according to a study by Standard & Poor’s published Dec. 24. Among AA rated nations, China’s ratio is 0.4 percent, while Japan’s is 2.9 percent, and for BBB rated countries, Mexico devotes 1.7 percent of its output to debt service and Brazil 5.2 percent, the report shows.

Auction Demand

Demand for Treasuries remains close to record levels at government debt auctions. Investors bid $3.04 for each dollar of bonds sold in the government’s $178 billion of auctions last month, the most since September, according to data compiled by Bloomberg. Indirect bidders, a group that includes foreign central banks, bought a record 71 percent, or $17 billion of the $24 billion in 10-year notes offered on Feb. 9.

Foreign holdings of Treasuries have increased 18 percent to $4.35 trillion through November. China, the largest overseas holder, has increased its stake by 0.1 percent to $895.6 billion, and Japan, the second largest, boosted its by 14.6 percent to $877.2 billion.

‘Killing Itself’

“China cannot dump Treasuries without killing itself,” said Michael Cheah, who oversees $2 billion in bonds at SunAmerica Asset Management in Jersey City, New Jersey. “They’re holding Treasuries as a means to an end,” said Cheah, who worked at the Singapore Monetary Authority from 1982 through 1999, and now teaches finance classes at New York University and at Chinese universities. “It’s part of what’s needed to promote exports.”

At least some of the increase in interest expense is related to an effort by the Treasury to extend the average maturity of its debt when rates are relatively low by selling more long-term bonds, which have higher yields than short-term notes. The average life of the U.S. debt is 59 months, up from 49.4 months in March 2009. That was the lowest since 1984.

The U.S. produced four budget surpluses from 1998 through 2001, the first since 1969, as the expanding economy, declining rates and a boom in stock prices combined to swell tax receipts.

Tax cuts in 2001 and 2003, the strain of the Sept. 11 terror attacks, the cost of funding wars in Afghanistan and Iraq, the collapse in home prices and the subsequent recession and financial crisis has led to the three largest deficits in dollar terms on record, totaling $3.17 trillion the past three years.

‘Demonstrates Confidence’

The U.S. needs to manage its spending decisions “in a way that demonstrates confidence to investors so we can bring down our long-term fiscal deficits, because if we don’t do that, it’s going to hurt future growth,” Treasury Secretary Timothy F. Geithner said in Washington on Feb. 9.

The Treasury Borrowing Advisory Committee, which includes representatives from firms ranging from Goldman Sachs Group Inc. to Soros Fund Management LLC, expressed concern in the Feb. 1 report that the U.S. is exposing itself to the risk that demand erodes unless it cultivates more domestic demand.

“A more diversified debt holder base would prepare the Treasury for a potential decline in foreign participation,” the report said.

Foreign investors held 49.7 percent of the $8.75 trillion of public Treasury debt outstanding as of November, down from as high as 55.7 percent in April 2008 after the collapse of Bear Stearns Cos., according to Treasury data.

Potential Demand

The committee projects there may be $2.4 trillion in latent demand for Treasuries from banks, insurance companies and pension funds as well as individual investors. New securities with maturities as long as 100 years, as well as callable Treasuries or bonds whose principal is linked to the growth of the economy might entice potential lenders, the report said.

“They are opening up a can of worms with the idea of all these other instruments,” said Tom di Galoma, head of U.S. rates trading at Guggenheim Partners LLC, a New York-based brokerage for institutional investors. “They should try to keep the Treasury issuance as simple as possible. The more issuance you have in particular issue, the more people will trade them -- whether it be domestic or foreign investors.”

White House Budget Director Jacob Lew said the Obama administration’s 2012 budget would save $1.1 trillion over the next 10 years by cutting programs to rein in a deficit that may reach a record $1.5 trillion this year.

“We have to start living within our means,” Lew said yesterday on CNN’s “State of the Union” program.

Still, about $4.5 trillion, or 63 percent of the $7.2 trillion in public Treasury coupon debt, needs to be refinanced by 2016. That gives the government a narrowing window as growing interest expense will curtail its ability to spend.

“There is roll-over risk,” said James Caron, head of U.S. interest-rate strategy at Morgan Stanley in New York, one of 20 primary dealers that trade with the Fed. “It’s a vicious cycle.”

To contact the reporters on this story: Daniel Kruger in New York at dkruger1@bloomberg.net; Liz Capo McCormick in New York at Emccormick7@bloomberg.net.

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net.

MOSCOW -- Russia greeted Japan's visiting foreign minister Friday with a stream of defiant statements amid a flare-up of tensions caused by the long-running dispute over several Pacific islands.

Foreign Minister Sergey Lavrov began talks with his Japanese counterpart Seiji Maehara by describing as "unacceptable" the government-sponsored rally in Tokyo on Monday, when top Japanese officials demanded that Russia returns the islands it seized at the end of World War II.

"That mars the climate in our relations and doesn't help their development," Lavrov said at a news conference after the talks. "When radical approaches take the upper hand in Japan concerning the issue of a peace treaty, it becomes pointless to conduct a dialogue on the issue."

The two countries have competing claims over four southern Kuril islands - known in Japan as the Northern Territories - and this has kept them from signing a formal peace treaty ending their World War II hostilities.

The islands, seized by Soviet troops during the final days of World War II, give Russia a military toehold just six miles (10 kilometers) off the northeastern tip of Japan's northern Hokkaido Island. The islands are surrounded by rich fishing grounds and are believed to have offshore oil and natural gas reserves, plus gold and silver deposits.

During Monday's rally in Tokyo, Japanese Prime Minister Naoto Kan demanded the return of the islands and called the recent visit there by Russian President Dmitry Medvedev "an unforgivable outrage." Medvedev fired back Wednesday, saying that more weapons will be sent to protect the islands as an "inalienable part of Russia."

Lavrov said Friday that Russia will pump more money into the Kurils and invited investors from other nations, including South Korea and China, to follow suit, drawing an immediate icy response from Maehara, who said that Japan would strongly object to that.

While reaffirming their nations conflicting claims to the islands, Lavrov and Maehara made some conciliatory statements Friday in an apparent attempt to ease a strain in ties.

Tensions have been building since November, when Medvedev became the first Russian or Soviet leader to visit the islands despite strong objections from Japan. Defense Minister Anatoly Serdyukov inspected military garrisons on the islands last week and said Moscow is planning to upgrade the troops' weapons there.

Earlier this week, the state news agency ITAR-Tass cited a Defense Ministry source as saying that some of the Mistral assault ships that Russia has contracted to buy from France would be deployed in the Pacific Fleet, as part of efforts to protect the southern Kurils.

As Maehara was holding talks with Lavrov Friday, Serdyukov's aide, Gen. Yuri Yakubov, was quoted by Russian news agencies as saying that the military plans to extend the runway on the biggest of the four islands to allow the landing of heavy Il-76 cargo planes capable of delivering hundreds of paratroopers and heavy vehicles. He also said the military will send new helicopters and armored vehicles to the islands.

Also Friday, members of a pro-Kremlin youth group held a rally outside the Japanese Embassy in Moscow that involved the flogging of an activist impersonating the Japanese premier. "We won't give up the Kurils!" the participants shouted.

The MSCI Asia Pacific excluding Japan index sank 1.4 percent to 458.11 at 2:18 p.m. in Hong Kong. Standard & Poor’s 500 Index futures lost 0.6 percent. The dollar and swiss franc rose against most of their major peers, Australia’s currency fell below parity to the greenback, and Vietnam devalued the dong by the most since at least 1993. Oil advanced as much as 1.2 percent in New York, while tin jumped to a record.

Mubarak handed day-to-day powers to Vice President Omar Suleiman while reiterating plans to stay on until elections in September, prompting U.S. President Barack Obama to urge Egyptian authorities to take further steps to resolve their nation’s crisis. Stocks extended losses after the China Securities Journal said policy makers adjusted the reserve requirement ratio for some banks and amid lower-than-estimated earnings from Rio Tinto Group to Newcrest Mining Ltd.

“These latest developments will be negative on sentiment for the market,” Kelvin Tay, Singapore-based chief investment strategist for UBS Wealth Management, said in a Bloomberg Television interview. “If oil prices move up, Asia ex-Japan is particularly vulnerable. We’re pretty much into a rate- tightening cycle right now given that we have inflationary pressures in a fair bit of economies.”

Losing Streak

MSCI’s Asia excluding Japan index has dropped 4.5 percent this week, the most since the five days ended May 21. Forty-two of the 76 companies on the measure that have reported quarterly earnings since Jan. 10 have missed forecasts, data compiled by Bloomberg show. Japan’s financial markets are closed today.

Rio Tinto sank 1.6 percent after reporting second-half profit of $8.5 billion, missing the $8.6 billion average estimate of 12 analysts Bloomberg surveyed. Newcrest Mining, Australia’s largest gold mining company, slipped 1.4 percent after posting first-half profit of A$438 million ($440 million). That was less than the A$457 million mean of four analyst estimates compiled by Bloomberg.

Reliance Communications Ltd., India’s second-largest mobile-phone operator and the flagship company of billionaire Anil Ambani’s business group, declined 4.6 percent. The company is forecast to report on Feb. 14 a 66 percent drop in its quarterly profit, according to the average of 25 analyst estimates compiled by Bloomberg.

‘Simmering’ Egypt

U.S. index futures are signaling that stocks may fall when markets open later today. The Dow Jones Industrial Average slid 0.1 percent yesterday, halting an eight-day rally. Kraft Foods Inc., the world’s second-largest food company, declined in extended trading after it lowered its full-year earnings forecasts because of rising commodity costs.

The dollar strengthened to $1.3567 per euro from $1.3603 in New York yesterday, when it advanced 1 percent. The greenback rose to 83.48 yen from 83.23 yen. The franc climbed 0.2 percent to 1.3151 per euro.

“There is Egypt, which still seems to be simmering over,” said Mitul Kotecha, Hong Kong-based head of global foreign- exchange strategy at Credit Agricole SA, a unit of France’s second-largest lender by total assets. “Clearly, this is all adding to a little bit more of a risk-averse environment.”

The Thomson Reuters/University of Michigan’s preliminary index of consumer sentiment rose to 75 in February from 74.2 in January, according economists surveyed by Bloomberg News before today’s report. The U.S. trade deficit probably widened in December for the first time in four months, according to a separate survey before data from the Commerce Department today.

Protests in Egypt

A Labor Department report yesterday showed first-time applications for jobless benefits dropped by 36,000 to 383,000, less than the 410,000 projected by economists.

President Obama said Egyptian authorities must make a “clear and unambiguous” statement that they are making immediate changes, saying the announcement by Mubarak failed to explain how or when the transition would occur.

Oil for March delivery rose 0.5 percent to $87.18 a barrel in electronic trading on the New York Mercantile Exchange, after gaining to as high as $87.77. Brent crude for March settlement climbed 0.5 percent to $101.36 a barrel while April futures, the most actively traded contract, climbed to $101.89 amid concern supply through Egypt’s Suez Canal may be disrupted.

Bonds, Metals

Egyptian dollar bonds gained yesterday after Mubarak’s speech, with the yield on the government’s 5.75 percent dollar bond due 2020 falling 11 basis points to 6.48 percent. Yields surged to a record 7.2 percent on Jan. 31 as hundreds of thousands of Egyptians flooded the country’s main squares and thoroughfares to demand Mubarak’s exit.

Mark Mobius, executive chairman of Templeton Asset Management’s Emerging Markets Group, said today he remains “very positive” about investing in Egypt and that the political turmoil there will lead to reforms.

Fresh protests were being planned with Friday prayers approaching. Previous rallies have already resulted in 300 deaths, the United Nations said.

Metals advanced on optimism that the recovery in the U.S. economy is becoming more broad-based. Tin climbed 1 percent to a record $31,800 a metric ton before trading at $31,620 a ton, and nickel jumped as much as 2 percent to $28,399 a ton.

Cotton, China

Grains increased on concern that smaller crops and rising demand will erode global stockpiles. Cotton futures jumped to a record for a third straight day, gaining as much as 2.7 percent to $1.9263 a pound. Wheat added 0.8 percent to $8.6925 a bushel and headed for its fourth weekly gain, the longest winning streak since August.

Australia’s dollar dropped to 99.77 U.S. cents from $1.0044 in New York yesterday after Reserve Bank Governor Glenn Stevens said policy makers had judged it was sensible to keep interest rates on hold as financial conditions are on the “firm side.” Vietnam devalued the dong by about 7 percent, seeking to curb the nation’s trade deficit. The dong slumped to as low as 20,893 per dollar, compared with 19,498 yesterday.

The South Korean won weakened 0.9 percent to 1,126.70 per dollar, erasing earlier gains, after the Bank of Korea unexpectedly held off from raising interest rates at a review today. Nine of 12 economists surveyed by Bloomberg forecast the Bank of Korea would raise its seven-day repurchase rate by a quarter of a percentage point to help tame inflation.

China’s central bank raised interest rates this week for the third time in four months, joining India, Indonesia, Korea and Thailand in having boosted borrowing costs this year.

The People’s Bank of China imposed differentiated reserve requirement ratios on some of the nation’s small and medium- sized lenders after January loan growth surged, the official China Securities Journal reported today, citing an unidentified person. The report didn’t specify whether the ratios were raised or lowered.

To contact the reporter on this story: Shiyin Chen in Singapore at schen37@bloomberg.net.

To contact the editor responsible for this story: James Poole at jpoole4@bloomberg.net.

Feb. 10 (Bloomberg) -- Inventories at U.S. wholesalers rose more than forecast in December as distributors tried to keep up with improving sales.

The 1 percent increase in stockpiles compared with a 0.7 percent gain median forecast in the Bloomberg News survey and followed an unchanged reading in November, Commerce Department figures showed today in Washington. Sales grew 0.4 percent to $371.5 billion, the highest level since August 2008.

Strengthening demand indicates orders to factories will keep climbing, which will keep manufacturing at the forefront of the economic expansion in coming months. The need to replenish stockpiles will probably contribute to growth in coming months.

“Demand is coming back and companies are seeing the need to keep their shelves well stocked,” said Sal Guatieri, a senior economist at BMO Capital Markets Inc. in Toronto. “Manufacturers are cranking up production to keep up with growing strength in exports and growing domestic demand.”

The median projection for wholesale inventories was based on a survey of 35 economists whose estimates ranged from an increase of 1.8 percent to a decline of 0.4 percent. The November reading was revised from a previously reported 0.2 percent decline.

Another report today showed the number of Americans filing first-time claims for unemployment insurance fell last week to the lowest level since July 2008, showing further strength in the labor market after the jobless rate declined to a 21-month low.

Jobless Claims

Applications for jobless benefits decreased by 36,000, more than forecast, to 383,000 in the week ended Feb. 4, Labor Department figures showed. Economists forecast claims would fall to 410,000, according to the median estimate in a Bloomberg survey.

The increase in stockpiles, which would normally lead to an upward revision to fourth-quarter growth, may reflect a surge in imports which would widen the trade gap and counter the positive contribution from inventories.

The Commerce Department will release trade balance figures tomorrow. The median forecast of economists surveyed by Bloomberg is for a $40.5 billion shortfall, up from the $38.3 billion recorded a month earlier.

Influence on Growth

Inventory rebuilding, a major driver of the early stages of the economic recovery, slowed in the fourth quarter as sales jumped, detracting 3.7 percentage points from gross domestic product, according to the Commerce Department data.

Wholesalers make up about 30 percent of all business stockpiles. Factory inventories, which comprise about 38 percent of the total, rose 1.1 percent in December, the Commerce Department said Feb. 3. Retail stockpiles, which make up the rest, will be included in the Feb. 15 business inventories report.

Wholesalers’ stockpiles of durable goods, or those meant to last several years, increased 0.8 percent in December, led by automobiles and electrical equipment, today’s report showed.

The gain in non-durable goods stockpiles may have been influenced by higher commodity prices. The average price of a barrel of crude oil traded on the New York Mercantile Exchange was $89.23 in December, compared with $84.31 in November. Corn, wheat and soybean futures this week surged to the highest level since 2008.

“Prices of many industrial and agricultural commodities have risen lately, largely as a result of the very strong demand from fast-growing emerging market economies,” Federal Reserve Chairman Ben S. Bernanke told a congressional committee yesterday.

At the current sales pace, wholesalers had enough goods on hand to last 1.16 months in December, close to the record low of 1.13 months reached in April.

Holiday sales rose 5.5 percent, the best performance since 2005, according to MasterCard Advisors’ SpendingPulse, which measures retail sales by all payment forms. Consumer spending rose at a 4.4 percent rate in the fourth quarter, the fastest since early 2006.

Sales Climb

Car sales began the new year on a strong note. General Motors Co. posted a 22 percent gain in January from a year earlier, while Toyota Motor Corp. saw a 17 percent increase, the companies announced last week.

“We’ve managed our business prudently, keeping inventories in line and lowering our incentive costs while remaining competitive,” Don Johnson, vice president for U.S. sales at GM, said on a Jan. 4 conference call.

Coach Inc., a leading leather goods producer and marketer, saw North American same-store sales rise 13 percent in the quarter ended Jan. 1 from a year earlier, Chief Executive Officer Lew Frankfort said on a conference call from New York on Jan. 25.

“Our current inventories support the strong underlying business trends, and will allow us to maximize sales this spring,” Michael Devine, Coach’s chief financial officer, said on the call. “We’ve been right sizing our inventories this year, bringing them up to more appropriate levels to support our growing businesses.”

To contact the reporter on this story: Bob Willis in Washington at bwillis@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net

Feb. 9 (Bloomberg) -- China’s central bank will likely need to increase interest rates further in coming months as the three moves since mid-October leave household wealth being eroded by accelerating inflation.

The People’s Bank of China yesterday raised the one-year lending rate by a quarter point to 6.06 percent and the one-year deposit rate an equivalent amount to 3 percent. The deposit rate remains almost 2 percentage points less than the pace of consumer-price gains, giving savers an incentive to buy goods and assets.

“There is still a substantial amount of heavy lifting to do in terms of rates -- at this stage of the cycle, the fact that we still have negative real rates is quite alarming,” said Glenn Maguire, chief Asia economist at Societe Generale SA in Hong Kong and a former adviser to Australia’s government.

Premier Wen Jiabao’s government has yet to return rates to pre-crisis levels, seeking to sustain the economy’s rebound to growth of about 10 percent. With overheating a danger in the first half of the year, policy makers are likely to raise their benchmarks further, order banks to set aside more cash as reserves and let the yuan appreciate to stem price pressures, Wang Qing, a Morgan Stanley economist in Hong Kong, wrote in a note yesterday.

In offshore trading in Hong Kong, the yuan climbed 0.1 percent yesterday to 6.5555 per dollar. Non-deliverable forwards strengthened 0.2 percent to 6.4275, signaling a gain of 2.6 percent in the next 12 months from the Shanghai close of 6.5938.

Holiday End

The central bank moved on the last day of a week-long holiday and before a report next week that may show consumer prices rose 5.3 percent in January, according to the median estimate in a Bloomberg News survey of economists.

That pace is still slower than the most recent inflation rates in Group of 20 nations including Brazil, Russia, India and Argentina, where consumer prices rose 10.9 percent in December from a year earlier.

“A rate rise was expected, but given they delayed to the end of Chinese New Year, it created anxiety over the potential severity,” said Gavin Parry, managing director of Parry International Trading Ltd. in Hong Kong. “Now that uncertainty is removed, the markets can focus on the January trade, and the producer prices and consumer-price data next week.”

Government figures expected next week are also forecast to show export growth accelerated in January and producer prices advanced at a faster pace, according to Bloomberg surveys.

Relative Performance

China’s benchmark Shanghai Composite Index has lost almost 5 percent over the past year, in part on concern at the impact of policy makers’ efforts to defuse a property-market bubble in the aftermath of a record lending boom. The MSCI Asia Pacific Index climbed 22 percent in that time by comparison.

A drought that’s threatening grain output and a New Year surge in lending are adding to inflation risks after money supply jumped more than 50 percent in two years. Economic growth accelerated in the fourth quarter to a 9.8 percent annual pace.

China’s 0.75 percentage point of increases in one-year rates since the global financial crisis compare with India raising borrowing costs seven times for a total of 1.75 percentage points. In South Korea, where policy makers meet this week to decide on rates, borrowing costs climbed 0.75 percentage point so far.

‘Accelerated Tightening’

Isaac Meng, a Beijing-based economist for BNP Paribas, said yesterday that he expected “accelerated tightening,” with rates rising by as much as another 1.5 percentage points. Before the financial crisis, the one-year lending rate was 7.47 percent, 1.41 percentage points higher than the level taking effect today.

In yesterday’s move, the central bank raised long-term rates for deposits by more than for loans. For savers, the increase was as much as 45 basis points, for five-year deposits.

“The goal is to encourage savers to keep their money in bank deposits rather than shifting to equities or property,” said Mark Williams, a London-based economist at Capital Economics Ltd.

Companies from Baoshan Iron & Steel Co. to Starbucks Corp. and McDonald’s Corp. have raised prices. While wages are also climbing, Chinese consumers are more concerned about inflation than at any time in the past decade, according to a central bank survey released in December.

Property Bubbles

China’s government aims to hold inflation at 4 percent this year, state broadcaster CCTV reported in December. Officials also want to limit the risk of property bubbles in an economy awash with cash.

China’s foreign-exchange reserves, the world’s biggest, climbed by a record $199 billion in the fourth quarter to $2.85 trillion, and banks extended 7.95 trillion yuan ($1.2 trillion) of new loans last year, exceeding the government’s targeted maximum of 7.5 trillion yuan.

New lending may have surged to 1.2 trillion yuan in January, according to the median estimate in a Bloomberg News survey of analysts. In December, the amount was only 481 billion yuan, a difference that highlights a pattern of banks lending more at the start of each year.

The government knows January’s inflation number will “look ugly” and wants to be seen as acting in the lead-up to the annual meeting of the National People’s Congress, the country’s lawmaking body, in early March, said Ma Jun, Deutsche Bank AG’s chief China economist.

Inflation is largely being driven by food costs. Last month, a jump in consumer spending ahead of the Lunar New Year holiday and bad weather that damaged crops may have contributed to a higher inflation reading.

Drought hitting parts of the country may cut grain output and undermine efforts to stabilize prices, Premier Wen said in comments reported by the state-run Xinhua News Agency last week.

Feb. 3 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke said the U.S. needs to see faster job growth for a sufficient time before policy makers can be assured the economic recovery has taken hold.

“With output growth likely to be moderate for a while and with employers reportedly still reluctant to add to their payrolls, it will be several years before the unemployment rate has returned to a more normal level,” Bernanke said today in a speech at the National Press Club in Washington. “Until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established.”

Bernanke said economic growth will pick up this year and the Fed’s purchases of $600 billion in Treasuries are “providing significant support to job creation and the economy.” At the same time, his emphasis on labor-market weakness means the central bank is likely to leave stimulus in place for a while, said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York.

“The Fed is still in a very growth-supportive policy stance,” said Feroli, a former Fed researcher. “I don’t think they make any premature feints toward heading to the exit.”

Bernanke, 57, gave no indication whether he’ll maintain or adjust monetary stimulus after the Fed finishes the asset buying in June. Policy makers have held the main interest rate near zero since December 2008.

Necessary Tools

“It bears emphasizing that we have the necessary tools to smoothly and effectively exit from the asset purchase program at the appropriate time,” he said.

The Fed chief repeated his call for Congress to come up with a plan to control the federal budget deficit and the projected surge in health-care costs that will fuel spending if left unchecked. He said twice in his speech that the fiscal challenge is “daunting.”

“Acting now to develop a credible program to reduce future deficits would not only enhance economic growth and stability in the long run, but could also yield substantial near-term benefits in terms of lower long-term interest rates and increased consumer and business confidence,” he said.

Bernanke cautioned lawmakers about the costs of not raising the debt ceiling, saying in reply to an audience question that such action could put the U.S. “into a position of defaulting on its debt and the implications of that, for our financial system, for our fiscal policy, for our economy, would be catastrophic.”

‘Very Remote’

The chances of such an outcome are “very remote but it’s not something you want to play around with,” he said.

The government will hit the $14.29 trillion legal limit on U.S. borrowing by the end of May, a little later than initially projected because tax revenue have been more robust than expected, the Treasury Department said in a statement yesterday.

Bernanke’s comments are his first since policy makers agreed at a Jan. 25-26 meeting to press on with their bond- buying plan. He is also scheduled to testify Feb. 9 at the House Budget Committee.

A report today from the Institute for Supply Management showed service industries in the U.S. expanded in January at the fastest pace since August 2005. Other recent data have shown gains in manufacturing and retail sales.

“The economic recovery that began in the middle of 2009 appears to have strengthened in recent months, although, to date, growth has not been fast enough to bring about a significant improvement in the job market,” Bernanke said.

Added to Payrolls

A Labor Department report scheduled to be released tomorrow will probably show that employers added 145,000 people to payrolls last month, and the jobless rate rose to 9.5 percent, based on the median estimates of economists surveyed by Bloomberg News.

Job gains at companies last year “were barely sufficient to accommodate the inflow of recent graduates and other new entrants to the labor force and, therefore, not enough to significantly reduce the overall unemployment rate,” Bernanke said. Private employers added an average of 112,000 jobs a month last year.

Bernanke may seek overall payroll gains of at least 200,000 a month for six months before becoming more comfortable with the recovery, Feroli said.

In response to a question after the speech, Bernanke said “the economy has to grow about 2.5 percent in real terms just to accommodate people coming into the labor force.”

Recent Report

In the second quarter of 2010, the economy grew 1.7 percent, followed by 2.6 percent growth in the third quarter and 3.2 percent in the fourth quarter, according to a report from the Commerce Department last week.

“Looking forward to 2011 we think it will be above 2.5 percent and therefore we expect to see unemployment declining over time,” Bernanke said.

Fed policy makers are showing little alarm over the rise in food and energy prices. The central bank’s Jan. 26 statement acknowledged rising commodity prices while saying that longer- term inflation expectations were stable and “underlying inflation” was still on the decline.

While prices of some “highly visible” items such as gasoline have “significantly” increased recently, “overall inflation remains quite low” and wage growth has slowed, Bernanke said. “These downward trends in wage and price inflation are not surprising, given the substantial slack in the economy,” Bernanke said.

Inflation Expectations

A measure of long-term inflation expectations, the 10-year breakeven rate between nominal and inflation-indexed bonds, was 2.34 percent yesterday, down from a high this year of 2.41 percent on Jan. 5.

The inflation gauge most closely watched by the Fed, the Commerce Department’s core personal consumption expenditures price index excluding food and energy, rose 0.7 percent in December from a year earlier, the smallest advance since records began in 1959.

Bernanke attributed rising food and energy prices primarily to increasing demand, saying that for commodities “the most important development globally is the fact that the world economy is growing more quickly particularly in emerging markets.”

Bernanke said rising prices were not the primary cause of turmoil in Egypt. The protests against Egyptian President Hosni Mubarak are having limited impact on global financial markets, where investors see few parallels with Iran’s 1979 revolution or the contagion that followed Thailand’s meltdown 13 years ago.

Today’s appearance extends Bernanke’s public defense of the asset purchases, dubbed QE2 for the second round of quantitative easing. The plan sparked a backlash from Republican leaders in Congress who said it may weaken the dollar. The dollar has gained 1.6 percent against a basket of six currencies since Nov. 3, the day the Fed announced its expanded asset purchases.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net; Joshua Zumbrun in Washington at jzumbrun@bloomberg.net.

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net

Feb. 3 (Bloomberg) -- China will curb its reliance on exports sooner than the U.S. can cut its budget and external deficits, removing a support from the dollar that will unsettle currency markets, Morgan Stanley’s Stephen Roach said.

“In the next three or five years China will move aggressively to increase its private consumption and reduce its surplus saving,” Roach, who is non-executive chairman of Morgan Stanley Asia Ltd., said in an interview in Oslo yesterday. “The U.S. talks the talk, but there is actually no shred of evidence whatsoever that America is going to reduce its budget deficit over that same period.”

China may post a trade deficit as early as this quarter as imports outpace sales abroad, the government said last month. The country’s reliance on trade to fuel economic growth close to 10 percent is now fading as its consumers grow wealthier, removing a key incentive for China to support the dollar. At the same time, the world’s largest economy estimates its budget deficit will swell to a record $1.5 trillion this year, as President Barack Obama channels stimulus to revive growth.

“If we don’t move to address our deficit before China addresses its surplus then we are going to be facing some pretty significant external funding constraints,” Roach said. “That would lead to a significant downward pressure on the dollar and/or higher long-term U.S. interest rates.”

China aims to reduce its trade surplus to less than 4 percent of gross domestic product in three to five years, central bank Deputy Governor Yi Gang said last year. Roach said the risk that China will cut its reliance on exports before the U.S. weans itself off external funding is greater than 30 percent.

‘Significant Risk’

“Nothing is inevitable, but I think there is significant risk in that direction,” he said.

The dollar has lost 13.5 percent against the euro since a June 7 high and is down 14 percent against the yen since an April 2 high. China pegs the yuan to the dollar.

The world’s second-largest economy is under pressure to allow the yuan to appreciate as inflation gains steam. Consumer prices rose an annual 4.6 percent in December, the Beijing-based National Bureau of Statistics said on Jan. 20.

China will need to allow the yuan to appreciate as much as 8 percent to avoid further inflation, according to Barton Biggs, who runs the New York-based hedge fund Traxis Partners LP.

China, the world’s biggest foreign holder of U.S. Treasuries, saw its portfolio of the securities fall by $11.2 billion to $895.6 billion in November.

Consequences

“If they were to engineer a major reduction in their dollar-based holdings there would be consequences for the currency that would lead to a sharp appreciation and that would impair their export competitiveness,” Roach said. “They are not prepared to take that risk.”

Still, China will gradually cut its holdings of U.S. assets as its consumers purchase more and save less, he said.

“The world in general -- the U.S. in particular -- can expect sort of a natural, organic reduction of China’s buying of dollar-denominated assets,” Roach said.

To contact the reporter responsible for this story: Josiane Kremer at jkremer4@bloomberg.net

To contact the editor responsible for this story: Tasneem Brogger at tbrogger@bloomberg.net

Feb. 1 (Bloomberg) -- China’s property market may be heading into a bubble as the economy’s reliance on real estate reaches a level close to the housing peaks in the U.S. and Japan, according to Citigroup Inc.

The CHART OF THE DAY shows investment in residential property accounted for 6.1 percent of China’s gross domestic product last year, the same level as the record in the U.S. in 2005 that was followed by the subprime crisis, said Shen Minggao, Citigroup’s China research head. It’s also about 2 percentage points away from Japan’s 1970s housing boom, he said.

“China’s property market is entering into a bubble stage,” Shen said in a phone interview. “It’s evident that property prices are no longer sustainable once the residential investments achieve above 8 percent of nominal GDP, and China may not be an exception.”

China’s property prices rose for 19th month in December, climbing 6.4 percent from a year earlier. The government last week increased the minimum down-payment for second-home purchases, told local governments to set price targets on new properties, and introduced taxes for homes in Shanghai and Chongqing. The measures followed two interest rate increases in the past four months and a ban on third mortgages.

Chinese Premier Wen Jiabao also said Jan. 18 the government will “resolutely” implement controls on the real estate market in the first quarter. China’s property prices will fluctuate within a 10 percent range this year, Shen said, adding that the country “may only avoid the bubble burst if current property tightening is effective.”

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Author:伊勢平次郎
Author: Nobuyoshi Ozaki

A long forty six years have passed since I stepped on to American soil. I have had various odd jobs in the past until I recently retired. Examples include working with Steven Spielberg as assistant director in a film called "1941." I was supervisor and later became Public Relation representative for Toyota Group - USA. My last occupation was a Senior Research analyst working in Silicone Valley for a major news paper from Tokyo, Japan. My spouse, Christine is a flight attendant, traveling often to the Middle East and Africa. We have spent three quarters of our life together as world adventurers. This photo was taken in Argentina. We now live in swampy Louisiana.